Debtors who face obstacles to paying off their debts often receive numerous demanding letters and phone calls, creating pressure to file bankruptcy and get rid of their debts. But creditors would rather keep you as a paying customer, while bankruptcy can have long-term effects on credit rating and the ability to make large purchases in the future. Before choosing bankruptcy, debtors may wish to consider a loan "workout" or other, less-drastic alternatives. This article covers the basics of dealing with creditors informally in order to negotiate mutually beneficial terms.
See FindLaw's Debt Negotiation and Settlement and Paying Down Debt for additional resources.
Of course, the first and best step toward dealing favorably with creditors is to pay all bills as they become due. But when life throws a curve ball, such as excessive medical bills, that is not always possible. If a debtor's financial problems are only temporary, he or she can simply ask creditors to accept lower payments or request that payments be scheduled over a longer period of time. Creditors may be more receptive to these ideas if the debtor has been a prompt payer in the past, or if they wish to avoid resorting to a court proceeding in order to collect on the debt.
Consumer credit counselors also can help work out a repayment plan. But some so-called "credit counselors" prey on overwhelmed consumers and promise "a clean slate" (often for a flat, up-front fee). They may promise to contact creditors and convince them to accept lower payments, or to charge lower fees and interest rates. In many cases, unfortunately, the only ones who end up in better financial shape as a result of these "efforts" (or the lack thereof) are the counseling organizations themselves, while the consumers are left with even fewer resources as a result of high fees and more delinquent debts.
See also Avoiding Credit Repair and Credit Counseling Scams.
The term "loan workout" is used to describe a more formal, mutually-negotiated modification of debt that does not involve a bankruptcy filing. Simply stated, a workout is an agreement worked out between the debtor and his or her creditors for payment of the debts. The agreement is negotiated without all the bells and whistles (and perhaps the stigma) of the bankruptcy process.
Workouts are sometimes called compositions or extensions. A composition is a contract between a debtor and two or more creditors in which the creditors agree to take a partial payment in full satisfaction of their claims. An extension is a contract between the debtor and two or more creditors in which the creditors agree to extend the time for payment of their claims. An agreement may be both a composition and an extension, or an agreement to accept less money over a longer period of time. The same laws govern both compositions and extensions.
By entering into a voluntary agreement by dealing with creditors informally, the debtor avoids the stigma attached to bankruptcy but achieves similar results -- discharge from a portion of his or her debts. In fact, the workout discharge is even broader than a bankruptcy discharge and does not affect the debtor's rights to file a future bankruptcy (unlike certain types of bankruptcy discharges). But the main advantage of a workout is that it is voluntary. In a workout, unlike bankruptcy, the majority of creditors cannot cram down concessions on dissenting creditors. All of the participating creditors must agree to the workout's terms.
